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An Introduction to Business Financing

Finding the money to start and grow a business is a dilemma almost all small business owners face at one point or another. Some businesses can't get off the ground without a substantial investment. Others can launch with very little cash, but find they need money to pay employees and advertise if they want to expand and grow.

There are many ways to finance a business, and the best choice will depend on your personal situation and the industry you’re in. Before you start to consider financing options, create a solid business plan. As your company’s foundation, the goals and strategies outlined in your plan will help you more accurately pinpoint the financing you’ll need.

Scraping together funds to start your own venture or having more financial flexibility to invest in business expansion both require a similar amount of planning. Your business plan should answer the following questions:

What products or services are you offering?

What will you do differently?

How big is your potential market?

How will you find customers?

How much and how frequently will they buy?

How much money (realistically) can you expect to make in a given time period?

How much money will you need to launch the business?

How much money will you need to keep it going until it's profitable?

How long will it take to become profitable?

Keep in mind that the exact amount of money needed to start a business varies greatly depending on the type.

According to the U.S. Small Business Administration (SBA), about 43 percent of businesses with employees need more than $25,000 to start, but the majority of businesses get started with less than $5,000. Take the time to thoroughly research what your startup expenses actually are to prepare yourself and avoid unpleasant surprises down the road.

If you need a loan or will be investing a sizeable amount of your own money, borrowing from friends and family, or applying for a bank loan, you will need a more formal business plan. Software such as Palo Alto Software's LivePlan can make writing it easier. There are also small business resource organizations that can help, such as the SBA nonprofits SCORE and the SBA’s Small Business Development Centers (SBDCs).

Here are some tips and options to consider when deciding how to finance your company:

Self-finance

According to the SBA, more than half of startups use their personal savings to launch their businesses.

Kelly Barker, co-founder of PREP Cosmetics, saved money years before she knew what business she'd start. Determined to leave the corporate world, she began saving $500 a month in a special account. Nine years later, when she shifted to the cosmetics business, she started putting "every dime" of her paycheck in the account while she studied the industry. By the time she launched PREP, she had saved over $250,000.

Today, she and co-founder Carole Aponte, MD, sell their products through their online store, in a brick-and-mortar store and boutiques.

Bootstrapping, or using existing financial resources to get a business off the ground, is also common among startups. Jordan Wan and Dan Zhou bootstrapped their sales recruiting platform, CloserIQ, by working as consultants to cover living expenses while they were building their business.

"We made sure to target consulting opportunities that had synergies with our company,” says Wan. “Many of those consulting clients actually turned into our first customers."

Apply for a Bank Loan

New businesses are risky, and banks are risk-averse. That’s why it can be difficult for small business owners to get a loan if their company is less than a year old or has less than $75,000 to $100,000 in annual sales.

For a bank to grant a loan to a startup, they will expect the founder(s) to:

have excellent personal credit (think 700+).

put at least 20 percent of their own money into the business.

have sufficient cash flow to be able to make payments to ultimately repay the loan.

pledge collateral (such as their homes) so the bank can recoup its money if the business fails.

be prepared (meaning they’ve done their research to understand the application process and are well-versed on the state of their business and own financials).

If you're becoming a franchisee of a well-known franchise with a track record of success, it may be perceived by lenders as less risky, so finding a loan may be a little easier.

Investigate Available Loan Programs

To help small businesses get financing, the SBA offers a number of loan programs, which often carry lower rates than traditional bank loans. If you qualify, these loan programs can help you get financing when banks turn you down.

Gina Cabell and Dayhna Carroll, two Philadelphia entrepreneurs, were turned down by a bank when they applied for a loan to start a cryotherapy center. They then approached The 504 Company (a nonprofit authorized by the SBA for certain loan programs) and were able to get a $135,000 loan through the SBA Community Advantage loan program. They used the money for leasehold improvements and to get the cryotherapy equipment installed, and they were able to open C.R.Y.O. Philadelphia in the summer of 2016.

Your local SBA office, Small Business Development Center or SCORE chapter can provide you information about SBA loan programs. You can also explore private companies like SmartBiz that help speed up the loan process to secure funding within weeks (versus the typical few months). Additionally, some franchises also offer financing programs to help new owners start their business. This information will usually be on their website and in Section 10 of the Franchise Disclosure Document.

Fund Through Credit Cards

Not every business owner has the ability (or the patience) to save up as much money as Barker did. Also, not all businesses require such a big investment to get started or to grow.

Sean DeSilva, owner of Every Last Spot, a cleaning service in Wichita, Kansas, put about $5,000 in personal savings into his startup, and supplemented those funds by using a credit card for all marketing expenses. He charged roughly $5,000, paying just the minimum each month while he got the business going. After a year, he was able to pay off the entire balance. "I probably paid about $500 in interest," he says. "I consider it a small price to pay for a business startup."

If you find you need more startup funds, individuals with excellent personal credit can sometimes get a credit card with a substantial line of credit attached. Bryan Clayton, CEO of GreenPal, which connects consumers with local lawncare professionals, had good credit history, which enabled him to secure a credit card with an $85,000 line of credit.

“We paid that off in the first year, and this year we're going to surpass $3 million in annual revenue," he says. Before you go this route, run the numbers to ensure your potential business returns can compensate for the risk you’re taking on, and be sure to track your expenses closely so you always know your exact debt amount.

Research Available Grants

The obvious benefit of a small business grant is that, unlike loans, they don’t need to be repaid. Plus, there are a number of options ranging from federal, state and local grants to private (corporate sponsored). However, many business owners find it difficult to qualify for grants that will ultimately help their business. There are a few reasons for this:

Grants are often hard to come by. Outdated websites and clunky databases make for inefficient research.

They’re typically specific to certain applicants, whether it be by industry, initiative or population group (like women, minorities or veterans).

They may also include stipulations about how funds are to be spent, whereas loans are more flexible.

It may still be worth your time and effort if the end result could be free funding for your business. Do some online research to find grants that might be suitable. Here are some ideas to get started:

Seek Out Investors

If you have an attractive business idea or plan for expansion, you may be able to enlist the help of other people’s financial resources in the form of angel investment, venture capital or crowdfunding. While angel investors usually provide a startup or entrepreneur with a one-time investment or steady roll of funds to get their business off the ground, venture capitalists bet on the returns of both startups and expansion plans.

An increasingly popular option that can’t be overlooked is crowdfunding, which is a great approach if you’re trying to streamline processes and collectively reach the masses with your idea. No matter the avenue, enlisting investors requires a well-thought out plan and some serious persuasion. Here are tips to further determine if an investor is right for your business:

Search angels and find the best match for your business via sites like AngelList and Gust.

Familiarize yourself with some of the big venture capital firms that are known for investing in early-stage startups.

Check out popular crowdfunding sites like Indiegogo or Kickstarter. You can leverage social media and other online channels more effectively if you start a crowdfunding campaign online.

Explore Alternative Financing Options

Other financing options exist, too, including borrowing from friends and family. Once a business is established and has proven sales and reasonably good credit, additional options for financing include online lenders such as OnDeck or Kabbage, equipment leasing, trade credit and factoring. Be sure you understand how much interest will cost you and what the loan terms are before you sign on the dotted line.

While an unpleasant reality, many businesses will fail. It’s important to have a backup plan in case you can’t get the financing you require. Whether you’re reworking your business idea while you freelance part-time or partnering to start on a new venture, you should adjust your financial needs accordingly to best meet your business goals.

Recap on How to Set Yourself Up for Successful Business Financing:

Solidify your business plan.

Determine your startup expenses.

Protect your credit.

Save money if possible.

Apply for available loans (federal, bank, franchisor).

Get creative with sources of income.

Use a credit card if you need money faster.

Apply for a grant if you have a targeted initiative or belong to a specific population group.

Seek the help of investors.

Work to improve your company’s worth through increased sales and maintaining good credit.

By using this guide and taking stock of your personal finances and your business’ needs, you’ll be able to select the financing option that is best for you and your business.

About the Author

Janet Attard is a small business expert who writes about finance and other small business topics on her BusinessKnowHow website. To learn more about Janet, visit businessknowhow.com.